Which of the following best describes systemic risk?

Systemic risk refers to the potential for a major disruption in the financial system that can impact the overall economy and not just specific entities or sectors. It encompasses scenarios where failures or losses in one part of the financial system can cause widespread instability, affecting multiple institutions or markets. This kind of risk can manifest during financial crises, where issues like bank failures, credit crunches, or market crashes ripple through the entire economy, demonstrating that the financial system is interconnected.

The distinction of systemic risk from other types of risk is crucial. For instance, risk tied to individual stocks pertains to the factors that could cause the stock price of a specific company to fluctuate, which does not necessarily impact the broader market. Similarly, risk related to a specific industry may affect companies within that industry but would not have the same broad implications as systemic risk, nor would it influence the entire financial system or economy on a large scale. Lastly, risk from economic downturns may be a component of systemic risk, but it is too narrow as economic downturns can affect various sectors differently and do not encompass the interconnected nature of systemic risk events.

Therefore, the most accurate description of systemic risk is one that emphasizes its effect on the overall financial system.